Lesson 2 of 8
Computing covenant headroom
Four covenants from one filing, the distance to each from the filed numbers, and why your computation disagrees with the compliance statement.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- Headroom is the distance from a filed number to a stated test, in both directions: how far the profit can fall, and how far the cost can rise.
- A covenant that tightens on a schedule shrinks the headroom without anything happening to the business.
- Every covenant here is defined in a credit agreement, so a ratio built from the face of the filing is an order of magnitude, not the test.
A maintenance covenant is a promise tested on a date. The work is to know how much has to go wrong before the test fails, and to know that before the quarter it fails in.
Compute the headroom on a real covenant
- Find the covenant. Carnival's fiscal 2025 filing lists the most restrictive terms on its revolving facility, unsecured loans and export credit facilities: minimum interest coverage of 2.5 to 1.0 at the 30 November 2025 testing date, rising to 3.0 to 1.0 from 28 February 2026; minimum issued capital and consolidated reserves of 5.0 billion; debt to capital no higher than 65 percent; minimum liquidity of 1.5 billion.
- Build the nearest filed version. Filed EBITDA of 7,273 million over interest expense of 1,349 million is 5.39 times.
- Measure the fall. At the 3.0 times test the earnings floor is 4,047 million, so EBITDA could fall 3,226 million, or 44.4 percent, before the test fails.
- Measure the rise. Holding earnings still, interest could rise to 2,424 million, up 79.7 percent, before the same test fails.
- Check the other three. Filed equity of 12,270 million is 7,270 above the 5.0 billion floor, a 59 percent fall of room. Cash of 1,928 million plus 4,500 million undrawn on the revolver is 6,428 against a 1,500 million minimum.
- Then find where your arithmetic disagrees. Filed total debt of 27,993 million over debt plus equity is 69.5 percent, which is above the 65 percent limit, while the company states it was in compliance on that date.
How far the earnings can fall before the coverage test fails
- Filed EBITDA, fiscal 20257,273$m
- Floor at the 2.5x test3,372$m
- Floor at the 3.0x test4,047$m
Step six is the lesson
Every one of those covenants carries the words "as defined in the agreements". Adjusted EBITDA is not the filed EBITDA. Consolidated net interest charges is not the income statement's interest expense. Debt to capital uses definitions of both that the filing does not print.
So the 69.5 percent figure is not a breach. It is evidence that the defined terms differ from the filed lines, by enough to move a ratio five points. An analyst who reported a covenant breach from that arithmetic would be wrong, and an analyst who skipped the arithmetic would not have learned that the definitions matter this much.
The filed computation is still worth doing. It gives the order of magnitude, the direction of travel across years, and the question to take to the credit agreement, which is filed as an exhibit under Item 15 of the same document.
A covenant that tightens on its own
The coverage test above steps from 2.5 to 3.0 times between two testing dates. Nothing about the company changes on that date, and the headroom shrinks from a 53.6 percent fall in earnings to a 44.4 percent fall.
Step-downs like that are ordinary in an agreement negotiated during a difficult period, where the lender grants room now in exchange for a tighter test later. They are the reason to read the schedule and not only the current level.
What a breach actually does
A maintenance covenant is tested on a date whether or not the company does anything. An incurrence covenant only binds when the company acts, such as raising new debt or paying a dividend.
A maintenance breach is usually not a demand for repayment. It is an event of default that gives the lender the right to accelerate, which is the beginning of a negotiation: a waiver, a higher margin, more security, a covenant reset. The same filing notes that an event of default under any agreement could, through cross-default and cross-acceleration clauses, make substantially all the company's debt due at once.
Check yourself
Filed EBITDA is 7,273 million and interest expense 1,349. Against a 3.0 times test, what is the headroom?
- The company is already in breach
- Earnings could fall 44.4 percent, or interest could rise 79.7 percent, before the test fails
- There is no way to tell without the credit agreement
Show the answer
Answer: B.
5.39 times against a 3.0 times floor is measurable in both directions, and both directions are worth stating because either one can move.Your debt-to-capital ratio from the filed balance sheet is 69.5 percent against a stated 65 percent limit, and the company reports compliance. What does that tell you?
- The company is misreporting
- The agreement's definitions of debt and capital differ from the filed lines, by enough to move the ratio several points
- The covenant has been waived
Show the answer
Answer: B.
Each covenant here says "as defined in the agreements". The gap between your arithmetic and the compliance statement is the size of that definitional difference.What does a maintenance covenant breach usually trigger first?
- Immediate repayment of all debt
- An event of default giving the lender the right to accelerate, which starts a negotiation
- An automatic bankruptcy filing
Show the answer
Answer: B.
Acceleration is a right, not an outcome. What follows is usually a waiver on new terms, and cross-default clauses are what make the negotiation urgent.Sources
- Carnival Corporation and plc, Form 10-K, fiscal year ended 30 November 2025, filed 2026-01-27, accession 0000815097-26-000007: the Covenant Compliance disclosure, the debt note, and the cross-default language.
- Item 15 of Form 10-K: the exhibit index where the credit agreements carrying these definitions are filed.
What this leaves out
- Every ratio computed here uses filed lines, not the agreement's defined terms, and the lesson shows that the two differ materially.
- Covenant levels are as disclosed at one fiscal year end. Agreements are amended, and a filing a quarter later can carry different tests.
- Interest coverage here uses filed EBITDA, while the product's published coverage ratio uses operating income, which is a lower and more conservative numerator.
- Nothing here is advice about any security.